Address by Chairman James E. Newsome of the
U.S. Commodity Futures Trading Commission before the
Bond Market Association
New York, New York - April 11, 2003

It is an honor to address the Bond Market Association this morning.
Since some of you may not be very familiar with the Commodity Futures
Trading Commission, I’d like to use my time here this morning to
tell you generally how we do business. Specifically, I want to
describe my philosophy of effective market oversight. I’d also
like to describe some of our current efforts, including some of our
rule modernization proposals and enforcement cases.

The CFTC oversees the trading of futures and options on commodities,
including those based on tangible physical commodities, such as
agricultural commodities, energy products, and metals, as well as
contracts based on financial measures such as stock indices, foreign
exchange rates, and government securities. Within our jurisdiction are
not only the organized futures exchanges in New York, Chicago, and
elsewhere but also the clearinghouses and futures commission merchants
who process transactions, the commodity pool operators and commodity
trading advisors that direct much of the trading activity, and a
variety of newer trading platforms, such as all-electronic commercial
derivatives markets that have developed up since passage of the
Commodity Futures Modernization Act two-and-a-half years ago.

Today, roughly 80% of the volume in futures trading is made up of
contracts based on financial measures. About 8% of the volume is in
agricultural contracts, and the remainder in contracts on precious
metals and energy products, such as crude oil and natural gas. I
should note that ag contracts, which only a few decades ago
constituted the entire futures market, are being traded just as
actively today as they have ever been. It’s simply that
financial contracts have grown astronomically since their initial
introductions in the mid-1970s. And it is for this reason that the
CFTC today is considered a financial regulator. I believe that the
incredible growth in the trading of these contracts demonstrates that
the derivatives markets are providing important risk management tools
to an ever growing number of investors and businesses in virtually
every sector of the U.S. economy.

The Commission is currently composed of four commissioners, including
myself, but may have as many as five. Typically, there are two
Democratic commissioners, two Republicans, and a Chairman that
represents the party of the Presidency. However, as an independent
regulatory agency, we have operated relatively free of partisanship,
which is a point that makes us very proud. Recently, we reorganized
and modernized the structure of the CFTC to make better use of our
resources in overseeing these important and dynamic markets. Our
Division of Market Oversight, which includes primarily economists,
conducts ongoing market surveillance and other key functions,
including reviews of contracts and exchange rules. Our other major
regulatory unit is the Division of Clearing and Intermediary
Oversight, which includes auditors and other staff who monitor the
financial and operational integrity of the clearinghouses and their
clearing members to ensure that customer funds are protected and that
safeguards are in place to prevent individualized financial problems
from being transmitted through the system. This division also handles
the registration of FCMs, pools operators, and trading advisors.
Supplementing the expertise of these two divisions is our Chief
Economist’s Office, which provides key analysis to the other
divisions and to the Commission, as well as our General
Counsel’s Office, which provides legal expertise to the
Commission and handles such matters as our appellate cases.

We have a very effective Division of Enforcement to investigate and
bring cases against those who attempt to defraud customers, manipulate
prices or supplies, or otherwise violate the Commodity Exchange Act
and the Commission’s rules. We have also formed an External
Affairs Office to respond to inquiries from the public, the press, and
the Congress and to communicate our position on issues pending before
the Congress or other agencies, including legislative matters that
could affect the markets we oversee.

In addition to our individual efforts, the CFTC also works
cooperatively with other financial regulators. As Chairman of the
CFTC, I sit on the President’s Corporate Fraud Taskforce. I am
also honored to be a member of the President’s Working Group on
Financial Markets with Secretary Snow, Chairman Greenspan, and
Chairman Donaldson. The members of the PWG were in immediate and
constant contact following the September 11th attacks. I
believe that coordination helped effect the smooth reopenings of the
financial markets. In fact, I believe that this sort of coordinated
decision-making, at the highest levels of government, should be
brought to bear in the event of any major market crisis, a topic which
I discussed with Bond Market Association representatives just last
week. My experience has been that this coordinated approach has
advantages, especially in markets that reach across regulatory
jurisdictions or that can affect other markets in the financial
system.

As I’ll discuss in a moment, the CFTC works cooperatively with
other agencies in a variety of formal and informal ways to address
circumstances in the derivatives markets. When I came to the
Commission in 1998, I could see that new technologies promised rapid
and meaningful improvements in the marketplace and that these changes
could bring new participants, greater liquidity, and increased
efficiency to the markets while also enhancing customer service,
lowering barriers to effective cross-border business, and generally
improving the availability and usefulness of risk management tools.
Yet it also quickly became apparent to me that the regulatory
structure did not always facilitate such progress. In fact, the
regulatory structure in some cases stifled innovation and efficiency.

Fortunately, help soon arrived in the form of the Commodity Futures
Modernization Act, a much-needed law that I consistently supported.
The CFMA embodied three key objectives: rule modernization for both
the trading platforms and the market users, legal certainty for the
over-the-counter derivatives markets, and legalization of futures
based on single stocks and narrow stock indices. The CFMA has also
provided the Commission with the flexibility to modernize its
oversight of these markets, something that I have greatly appreciated
because it has allowed us to make key changes in how we approach the
important task of protecting market participants and ensuring the
integrity of the market mechanisms.

I have a straightforward market oversight philosophy that reflects two
basic principles. First, for the legitimate business activities of
those who, through innovation and fair competition, bring to the
marketplace greater liquidity, more useful risk management tools,
better use of technology, more efficient pricing, and enhanced
customer service, I believe we should provide the most flexible and
responsive oversight structure possible.

But, for those who attempt fraud or manipulation, I believe in the
most prompt and aggressive exercise of our enforcement authority under
the Commodity Exchange Act. More specifically, my view is that the
proper deterrent to wrongdoing should not be more prescriptive or
burdensome regulations that adversely affect legitimate activities
but, instead, tough enforcement actions against those who would try to
operate outside the established rules.

I have noticed that the temptation to resort to prescriptive
regulations, which often take a very static view of markets or
technology, has sometimes been hard to resist for regulators. I
believe that successful market oversight requires an agency such as
ours, one that is witnessing great change in the markets, to be
innovative and to adapt to changing market realities. The CFMA affords
the CFTC the opportunity to do so through its targeted flexibility;
through principles-based rules, it allows oversight to be tailored to
the nature of the particular contracts being traded, the
sophistication of the market participants involved, and the manner in
which those contracts are traded. Overall, the framework reflects a
common sense approach to market oversight and empowers the Commission
to fulfill its important public policy mission without stifling the
innovation driven by new technologies or the evolving needs of market
participants.

A good example is the first major set of rule modernizations that the
Commission was able to implement very quickly after passage of the
CFMA. These rule modernizations affected exchanges and other trading
platforms. Congress also allowed the CFTC to review the rules
affecting market intermediaries, such as futures commission merchants,
pool operators, and trading advisors. After soliciting input from
market participants through hearings and roundtables, we recently
published a number of proposals for public comment, some of which
address issues that have challenged the Commission for years. The
proposed changes include rule modernizations affecting not only our
traditional registrants but also changes to improve access to risk
management tools for mutual funds, insurance companies, and banks. I
would encourage each of you who may be interested to comment on these
proposals because the insights and concerns of market participants are
invaluable to the Commission as we seek to improve the way we oversee
these markets.

My desire to pursue this continuous improvement in our oversight is
due to my belief that one-size-fits-all regulations and inflexible
prohibitions that ignore unique risk management needs are effective
neither in maximizing the efficiency of our various markets nor in
minimizing the risks to participants. Rather, I believe an oversight
structure which permits innovation in risk management while
maintaining and enhancing workable safeguards is not only the best
protection against systemic problems, but also a good provider of
legal and regulatory certainty for business decision-makers.

The increasingly more widespread use of derivatives to manage risk not
only benefits direct users but also contributes to greater
flexibility, resiliency, and efficiency in the economy. The importance
of these markets only strengthens my determination to protect them
from attempts at fraud, abuse, or manipulation. Our efforts to
modernize CFTC rules to allow greater flexibility and innovation for
legitimate business activities must be accompanied by our continuing
determination to use strong enforcement actions to deter illegal
activities. Accordingly, it has been my consistent policy to bring the
Commission’s enforcement capabilities fully to bear on anyone
who attempts to compromise their integrity, efficiency, or
reliability.

In the short time since passage of the CFMA, which clarified our
authority over illegal off-exchange forex bucket shops, the Commission
has used that authority to bring almost two dozen cases. At the end of
last year, the Commission imposed a $5 million civil monetary penalty
against two firms in connection with false reporting and attempted
manipulation. Last month, we filed a complaint in federal court in
Houston against a former major energy trading company, alleging
manipulation of natural gas prices and the online operation an illegal
futures exchange. Also last month, another large energy trading firm
entered into a consent order with the CFTC penalizing it $20 million
for the reporting of false information to energy price reporting
services. Our Enforcement Division is actively engaged in other energy
sector investigations, which may result in further charges being
filed.

During these investigations, the CFTC has cooperated closely with
other regulators. The cases are complex and require substantial time
and resources to develop, but it is my goal to identify the
wrongdoers, and, just as importantly, to exonerate those not involved,
as expeditiously as possible so that the energy and energy derivatives
markets can work toward restoring the confidence of market
participants and the public.

Investigations and enforcement cases are not the only ways in which we
are cooperating with other oversight agencies. For example, earlier
this year, we jointly hosted with the Federal Energy Regulatory
Commission a conference on possible solutions to credit risk problems
in the energy sector, at which I was made even more keenly aware of
the challenges facing those who very much need the risk management
tools offered by OTC energy derivatives. The CFMA made possible one
potential solution, the clearing of OTC derivatives by futures market
clearinghouses. The Commission has been working since early last year
with the New York Mercantile Exchange, the Intercontinental Exchange,
and EnergyClear on initial efforts in this area because we recognize
that centralized clearing can do much to address counterparty credit
concerns, which appear to be a key concern among potential market
users.

As a follow-up to discussion at that conference, FERC Chairman Pat
Wood and I wrote jointly to Congress to express our strong support for
certain previously proposed amendments to the bankruptcy code that
could help to alleviate counterparty credit risk concerns by ensuring
the enforceability of acceleration and termination provisions, netting
clauses, and other contractual safeguards in the event of one
counterparty’s insolvency. I know that the Bond Market
Association is very familiar with these particular legislative
initiatives.

A key reason that I have expressed my support for those amendments --
most recently with Chairman Wood but also previously as a member of
the President’s Working Group on Financial Markets -- is that
they would provide market participants with a greater degree of
certainty that the key protections which they carefully negotiate into
their transaction agreements will be honored and enforceable should a
problem ever arise. I believe that certainty for counterparties is
critically important to the smooth and efficient operation of markets.
If laws, regulations, or even enforcement policies are unclear, then
market participants must factor that uncertainty into their decisions
and this, in turn, can often result in missed opportunities,
inefficient results, or misallocated resources.

In closing, let me express my high regard for the staff and leadership
of the Bond Market Association. They do a good job of representing
your interests in Washington. I have enjoyed our meetings and find
their input and insights educational. Thank you again for the
invitation to be here this morning and for allowing me to update you
on our efforts at the CFTC.